Bailouts of bad debts do more harm than good
- Published on Wednesday, 17 April 2013 11:03
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Household debt relief schemes being discussed in some Gulf Cooperation Council (GCC) member countries could increase moral hazard, Fitch Ratings says. They need to be coupled with regulation to deter reckless borrowing and lending to stave off negative implications for banks and sovereigns.
We expect the schemes, like the one approved by the Kuwaiti parliament earlier this month, to be limited in scale and duration in order to reduce risks of moral hazard and costs to the sovereign. A recurrence of a consumer debt boom could occur if borrowers take on excessive amounts of debt in the expectation they will be cleared by the authorities. This would likely be detrimental for banks’ asset quality.
Over the past two years, central banks throughout the region have tightened retail lending regulations on personal unsecured loans to enhance lending criteria. These measures should benefit bank asset quality in the longer term. However, full implementation of stricter underwriting standards is challenging for many GCC banks because they lack a working credit bureau and other reliable data.
If loans are restructured as a result of a debt relief scheme, the solution needs to be sustainable for the borrower. Otherwise banks will only store up bad loan problems. For instance, the UAE debt settlement fund sets monthly repayments for restructured loans at an affordable level of the borrower’s salary.
Debt relief schemes can raise costs for banks, but we expect their impact on profitability to be limited and manageable as long as the programmes remain narrow in scope.
If the cost of the debt relief falls more on the sovereign, there could be implications for its creditworthiness. Those implemented so far are small compared to sovereign resources in the countries involved. Nonetheless, the risk of moral hazard triggering excessive borrowing and lending could have bigger sovereign implications. This emphasises the need for debt relief measures to be coupled with regulations to deter a rapid build-up of consumer debt.
Governments in the GCC are increasingly focused on improving social conditions and wealth distribution. The Kuwaiti parliament recently approved debt relief measures for its nationals for personal loans taken from commercial banks before end-March 2008. This plan covers KWD744m (USD2.6bn) of consumer loans and needs to be approved by the Emir. The UAE set up an AED10bn (USD2.7bn) debt settlement fund to clear defaulted debts of its citizens in 2011, but to date there has only been limited utilisation.
Read the story from Fitch Ratings.Lending standards may have been tightened up a bit in the Gulf, but they are still loose. The main beneficiaries of debt bailouts are the banks. First, they get to clean up their bad debts as the government takes them off their hands. Second, with fresh capital to lend and a clear sign from the government that bad debts will be covered, they go off on a new lending spree to raise their profits and make their shareholders happy.
Consumers feel happy too; their bad debts are cleared and banks start chasing them again for new loans. Yes, lending tightened up in 2008/2009, but last year, banks struggled to grow their loans so this year they have raised the lending limits to individuals. They are now targeting their customers aggressively with new credit cards, higher limits, personal loans, mortgages and auto loans. All this creates is more debt in the system in the long run. Any slowdown in economic activity will bring this pile of debt down again. Banks and consumers will be looking at the government to come in and pay it off… and it will. All the government has to hear are two words “Arab Spring” and it will start writing checks to the banks.
Read our previous posts mentioned above to get a better picture of the conundrum these governments are in.